What is it and why should directors be concerned?
Directors have a fiduciary duty to promote the success of the business for the benefit of its shareholders. However, when a company begins to head towards insolvency, the directors’ should redirect their focus towards protecting the creditors’ position from worsening further.
Where a director ought to have known that the company was insolvent and failed to cease trading at an earlier point, a director can be personally liable for any resulting losses to the company and therefore, its creditors.
As an example, if an insolvent company had an amount owed to its creditors in the region of £2m at T0 but then trades on for a further 3 months where the losses increase further to £2.5m, then the directors can be personally liable for £500,000. The reason for this, is that they should have been taking steps to wind down the business and cease trading at a much closer time to T0, thus avoiding those increased losses.
A liquidator or an administrator may initiate a wrongful trading claim against an offending director.
Whilst all directors are expected to demonstrate a basic level of competence, and ignorance is no defence, those with a higher level of qualification will be held to a higher standard. Therefore, a qualified accountant serving as a director of a company, would be expected to recognise signs of insolvency at an earlier stage and as a result, may face more severe consequences.
Directors need to tread carefully when they begin to have cashflow problems and they should make sure that if the position is expected to worsen in the short term, then it should really only continue trading in anticipation that in the long term, the company will return to a solvent position.
Seeking early independent advice from an Insolvency Practitioner is wise, as well as considering having Directors & Officers insurance in place.
What changed in 2022?
The Supreme Court’s judgement in BTI 2014 LCC v Sequana marked a significant shift in how the insolvency profession approaches potential wrongful trading claims.
Before 2022, it was always felt there was a clearcut moment in time that when insolvency commenced, and creditors’ interests prevailed. However, in Sequana the Court found that there was no one point in time at which a real risk of insolvency could be placed, but that instead there was a sliding scale during which the risk of insolvency becomes more acute. As a result, the directors’ obligations shift from shareholders to creditors, as the likelihood of insolvency goes from being remote to inevitable / irreversible/ unavoidable.
As a result of this interesting judgement, Insolvency Practitioners are now more likely to scrutinise the events leading up to an insolvency, examining whether the directors ought to have taken appropriate steps to ensure that the position did not deteriorate further.
What does that mean for a credit controller?
When you start to have difficulties in recovering a debt, find out why and make a log of the communications. Consider also whether you want to continue providing credit to the company. If you are a supplier, consider insisting on cash on delivery for future supplies.
Events leading up to an insolvency are crucial and maintaining a communication log could prove to be pivotal. Key, to bringing a claim against an offending individual, and essential in shifting the timeline back to an earlier date, where directors should have known the company was heading towards an insolvency.
What does this mean if you are director seeing cash flow difficulties?
If you finding it difficult to meet payment obligations, you should seek independent advice from a solicitor or Insolvency Practitioner sooner rather than later. The earlier this step is taken, the greater the options will be for you and it will mitigate any wrongful trading allegations aimed at you.
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